Issue #45

Free Cash Flow and The $240,000 That Wasn't Cash

Happy Friday,

Welcome back to Balance Sheet. Every issue follows one real business with a problem hiding in its numbers, walks through what went wrong on the books, and shows you the fix.

Today's issue is about free cash flow, the cash a business has left after paying to keep itself running. Hollis Grant runs an aerial drone survey company in Tucson, Arizona, and her 2025 income statement showed $240,000 of net income. When an investor asked for her free cash flow, the answer was negative $55,000. A $400,000 investment offer was on the table, and it nearly walked out the door. The fix was a free cash flow statement that separated the cost of keeping the business running from the cost of growing it.

Let’s find out how it started and what it can teach you before you sit down with an investor or a lender.

The question in the second meeting

Skyline Survey Co. flies LiDAR-equipped drones over construction sites and solar farm parcels, turning raw terrain into 3D maps that engineers use to plan grading and layout. Hollis started it in 2021 with one drone and a used pickup. She had eight employees and contracts with three utility-scale solar developers by 2025.

In March, a Phoenix family office offered $400,000 for a 20% stake. The first meeting went well. Revenue was $1.9 million, net income was $240,000, and profit had grown every single year.

The second meeting opened with one question: "What was your free cash flow last year?"

Hollis didn't know. Her CPA, Martin Alvarez, did. It was negative. Oops!

Here’s what happened next.

What free cash flow actually measures

Net income follows accrual accounting. Revenue is recorded when the work is done, and the cost of a $95,000 drone rig gets spread over several years through depreciation. Both rules make sense for measuring performance. Neither one tells you how much cash showed up.

Free cash flow (FCF) does. It starts with cash flow from operations and subtracts capital expenditures (CapEx), the money spent on long-term assets like equipment, vehicles, and buildings.

FCF = Cash flow from operations - Capital expenditures

Cash flow from operations comes from net income, adjusted for everything that didn't actually move cash.

Cash flow from operations = Net income + Non-cash expenses - Increase in working capital

Here's how Skyline's 2025 broke down.

Two lines did massive damage.

The first was accounts receivable. Solar developers paid on net 60 and often stretched to 90, so $120,000 of 2025 revenue was still uncollected at year-end. This income was real, and it was taxable. It just wasn't spendable yet. (If Tuesday's issue on days sales outstanding felt familiar, this is the same problem showing up one statement later.)

The second was CapEx. Hollis bought three new drone rigs at $95,000 each. On the income statement, those purchases appeared as a modest depreciation charge. On the cash flow statement, all $285,000 left the bank in 2025.

Why investors look here first

Net income depends on accounting choices: when revenue counts, how fast assets depreciate, and what gets accrued. Free cash flow is much harder to dress up because cash either left the bank or it didn't. It shows what the business can actually use to repay debt, pay its owners, or reinvest.

The family office also looked at the trend, and that worried them more than any single year.

Year	Net income	Free cash flow
2023	$150,000	$110,000
2024	$195,000	$40,000
2025	$240,000	($55,000)

Profit climbing while free cash flow falls is a classic warning sign. It can mean customers are paying slower, inventory is piling up, suppliers want faster payment, or the business needs constant reinvestment just to stand still.

From the outside, the investors couldn't tell which one it was.

Negative FCF can still be good news

Martin pulled the CapEx line apart. The three drones weren't the same kind of purchase.

One replaced a 2021 rig that had logged over 1,400 flight hours and could no longer hold calibration. That was maintenance CapEx, the spending required to keep the business operating at its current size.

The other two were bought for a new three-year contract with a solar developer worth $540,000 a year. That was growth CapEx. Without those rigs, there was no new contract.

Maintenance FCF = Cash flow from operations - Maintenance CapEx Maintenance FCF = $230,000 - $95,000 = $135,000

This number answered what the investors really wanted to know: how much cash does this business throw off before it chooses to grow? The answer was $135,000 a year, with a signed contract behind the extra spending.

Martin added one more point. If receivables came back down to their normal level, operating cash flow would rise by roughly the same $120,000.

What Hollis brought to the third meeting

She rebuilt the package around cash.

A three-year cash flow statement, with CapEx split into maintenance and growth.
The signed solar contract, with projected contribution margin covering the $190,000 cost of the two new rigs within eighteen months.
A collections plan. Two developers agreed to net 45 terms in exchange for priority scheduling.
A quarterly FCF report, promised to the investors for as long as they hold equity.

The family office came back at $400,000 for a 22% stake, close to the original offer and far better than where the second meeting had left things.

Three cautions before you use it

FCF is lumpy. One big equipment purchase can make a single year look terrible and the next year look great. Look at three to five years together.

High FCF can also mean underinvestment. A business that keeps postponing replacement equipment will show strong cash flow for a while, then pay for it later with breakdowns and lost jobs.

And nobody reports FCF for you. Small business financial statements rarely include a line for it, so you'll calculate it yourself from the cash flow statement or from the income statement and two balance sheets.

Back to Skyline

Hollis's $240,000 of profit was real. It was also tied up in drones and unpaid invoices, and an investor spotted that faster than she did.

Run the FCF calculation every quarter. Split your CapEx into what keeps the lights on and what builds the next stage. You'll have the answer ready before anyone asks.

Lenders ask a related question about whether your earnings can comfortably carry your debt. On Tuesday, a greenhouse owner in Pennsylvania finds out what happens when a variable-rate loan starts eating into the earnings meant to cover it.